Budgeting in the Real World

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Exotic Newcastle Disease, one of the most infectious bird diseases in the world, kills so swiftly that many victims die before any symptoms appear. When it broke out in Southern California two years ago, it could have spelled disaster for the San Diego Zoo.

“We have one of the most valuable collections of birds in the world, if not the most valuable,” says Paula Brock, CFO of the Zoological Society of San Diego, which operates the zoo. As state authorities ordered the slaughter of millions of chickens, and federal agents went door-to-door killing household parrots and other feathered pets on the spot, keeping the disease out of the zoo and its nearby Wild Animal Park became an enormous unbudgeted expense.

Bird exhibits were shut to the public for several months (the disease, which is harmless to humans, can be carried on clothes and shoes). The tires of arriving delivery trucks were sanitized, as were the shoes of anyone visiting the zoo’s nonpublic areas. Zookeeper uniforms had to be changed and cleaned daily. And ultimately, the zoo, with $150 million in revenues, spent almost half a million dollars on quarantine measures in 2003.

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It worked: no birds got sick. Better yet, the damage to the rest of the zoo’s budget was minimized by another protective measure: the monthly budget reforecast. “When we get a hit like this, we still have to find a way to make our bottom line,” says Brock. Historically, zoo scientists would have been far more worried about the disease’s effect on their budgies than their budgets. But thanks to new planning processes Brock had introduced a year earlier, the zoo’s scientists were able to raise the financial alarm as they redirected resources to ward off the disease. “Because we had timely awareness,” she says, “we were able to make adjustments to weather the storm.”

Budget reforecasting is nothing new. (The San Diego Zoo’s annual static budget was behind the times before Brock took over as CFO in 2001.) But the reaction of the zoo’s staff shows the benefits of Brock’s immediate efforts to link strategy to the process. It’s a move long touted by consultants as a key way to improve people’s involvement in budgeting.

“To keep your company on a path, it has to have some kind of map,” says Brock. “The budgeting-and-planning process is that map. I cannot imagine an organization feeling in control if it didn’t have that sort of discipline.”

A Little Better All the Time

When CFO magazine examined the state of corporate budgeting and planning (B&P) seven years ago, the only common ground between finance and operating units was that they all hated the process. Line managers saw B&P as an irrelevant and time-consuming data-entry project. It was equally cumbersome for finance departments, which distrusted the results. And both sides despised the ensuing numbers negotiations, which tended to reward the most politically savvy hagglers.

Back in 1998, the consultants’ general prescription for fixing B&P was threefold: simplify it, share the information widely, and link it tightly to strategy. Technology helps, but the key to success is making people accountable.

Finding a cure hasn’t been easy. But the good news, as the San Diego Zoo demonstrates, is that the prescription applies to companies and organizations of all sizes. Seven years ago, only a handful of large companies dared embark on what experts termed “the ultimate reengineering project.” And although the fixes vary, one thing is clear: “Companies of all kinds are doing a better job of getting line managers, whose decisions drive spending and revenue, to participate willingly in the process,” says The Buttonwood Group LLP’s Lawrence Serven, who wrote CFO’s 1998 survey and helped design the current one.

That buy-in has had a dramatic effect. Today, according to CFO’s survey of 260 finance executives, almost half (47 percent) believe most employees are completely satisfied with the B&P process, compared with just 16 percent who thought so in 1998. And the number who say the value of the B&P process clearly outweighs the cost in time and effort has also increased, from 47 percent to 65 percent.

That’s not to say Corporate America has tamed the budgeting beast. “It’s great to see progress, though perhaps with the mountain of articles and seminars and software offerings over the years, we would expect to be even further ahead,” says Serven. For one thing, he warns, “this more favorable view of B&P is not necessarily the result of improved reliability.” Indeed, perceived reliability has fallen somewhat: on a scale of 1 to 4 (where 1 is “Not at all” and 4 is “Completely”), CFOs gave the process a 2.9 for reliability in 1998 versus just 2.5 today.

Moreover, politics still dog the process. Even today, a majority of respondents told CFO that office politics had some influence. “The politics are always going to be there,” says Serven. But as the technology has improved, he adds, it has helped companies achieve certain basic best practices, such as identifying the key drivers of the business and attaching long- and short-term targets to those drivers. “Transparency [on those issues] goes a long way toward reducing the politics.”

That same transparency has also allowed companies to successfully make the link between process and strategy. The result? “People working on a budgeting process that is clearly guided and focused by strategic initiatives spend less time arguing about irrelevant details and more time focusing on stuff that matters,” says Burke Willis, practice director of financial management at benchmarking firm APQC. A recent APQC study shows that the median number of days it takes to prepare the annual budget — a major source of frustration for all concerned — is lower for companies that align their plan with strategy numbers (63 days) than for those that do not (80 days).

Linking Strategy to Budgeting

A case in point is the San Diego Zoo. When Brock, a veteran of KPMG and ITT, arrived, the strategic plan had no input from finance whatsoever. The zoo’s goal is to become “a world leader in connecting people with wildlife and conservation.” But there was no connection between that goal and the zoo’s resources, even though the latter were improving (revenues have increased from $100 million to $170 million over the past 10 years). “There was a 10-year plan in a narrative sense, but not in terms of how we were going to make it happen financially,” she recalls. In 2002, she revamped the strategic plan to incorporate a financial plan.

Budgeting, meanwhile, was an annual low-level department exercise, with no midyear updates. “That gap [between high-level strategy and budgeting] had to be bridged,” she says, a goal that “had to be understood at the highest levels of the organization, but also sold to the lowest levels.”

That required a sensitive touch with the zoo’s scientists and animal keepers. “You don’t want to overload your professionals with something they perceive to be bureaucratic number-crunching,” she says. “On the other hand, nobody knows that side of the business better than they do.” Six months into the job, Brock rolled out software by Timeline Inc. to pull data from the general ledger, and created templates for 145 departments. She limited the number of budget items in each department’s report, however, and offered extensive training. “A keeper in a primate exhibit doesn’t have many things on the list — but nobody knows that list better,” says Brock. Better yet, she adds, department heads now have an improved understanding of the collective impact of their decisions. A good B&P process, she explains, “by its very nature creates healthy discussions and buy-in.”

As APQC’s Willis suggests, it also speeds the process. Each department now does a close and reforecast within 7 to 10 days of the end of each month, and Brock is now working on a 13-month rolling forecast that will close the timing gap between the budget and the 10-year strategic plan, which is refreshed annually.

Making sure budgets are linked to overall strategy is essential, whether the organization is the not-for-profit Zoological Society or the world’s largest software company. Microsoft Corp., with 60,000 employees in 99 countries, tackles B&P on a much larger scale. But Marc Chardon, CFO of the company’s Information Worker business group, says Microsoft also has processes to ensure that the budgets of its seven businesses are based not only on their own product-development strategy, but also on corporate strategy.

At first blush, that would seem to be an enormous challenge. Indeed, Microsoft formally converted its various engineering operations into seven distinct businesses about two and a half years ago, in part because centralization had proved too unwieldy. Another problem was that those engineering groups — which produced Microsoft software — had no direct responsibility for sales, and so were “more focused on product than revenue,” observes Chardon. Distributing the once-independent field sales force into the P&Ls of the groups “made the matrix more complex,” he says, “but made the [business group] CEOs more accountable.”

At the time of the reorganization, then-CFO John Connors also proposed that each business group have its own CFO who would be responsible for that group’s strategy, business modeling and planning, and analysis of market performance and operating expenses. (CFO duties such as treasury, tax, investor relations, and corporate compliance remain centralized.)

Yet the “paradox” of running a company of Microsoft’s size, says Chardon, is figuring out the right balance between businesses that are returning cash (such as the Information Worker business) and those that are considered investments (such as Home and Entertainment). Such trade-offs even exist within each business, so that B&P “is right on the cusp” between centralization and decentralization.

To integrate the process, each business reviews its strategy, proposed changes, and investments at the end of every second fiscal quarter with CEO Steven A. Ballmer. The third quarter begins with a “deep midyear review” that examines operational trends by geography, business lines, and channels. And based on this “bottom-up view of what the next 18 months might look like,” says Chardon, the corporate office begins setting targets for each group. That process, he says, “basically culminates in a conversation between [Ballmer] and each business group CEO about the ambition for the next year. And that ambition frames the budgeting process.” Only then does the actual budgeting — roughly an eight-week effort — begin at each of Microsoft’s businesses.

Less Is Always More

Of course, the simpler the budget, the easier it is to tie to strategy. Companies have had a surprisingly difficult time accepting that less is more, but those that do often see dramatic results. Such was the case at Erickson Retirement Communities. “We’d try to load the data into our ERP, and a third of the spreadsheets would get kicked out because something was wrong,” recalls Craig Erickson, vice president of financial planning and analysis at the private, family-controlled company.

But when new, Web-based budgeting software was introduced in 2002 (in this case, Hyperion Planning and Essbase XTD), the project manager resisted the temptation to simply replicate the existing spreadsheets. Instead, the budget itself was revamped to capture less detail.

“That was a dramatic process change,” says Erickson. About 90 percent of the participants at 11 different retirement communities now use the same basic 15 accounts. “Before, our dining departments would probably budget 50 different accounts — amount of frozen fish, fresh fish, baked goods, and so on,” he says. “All we really care about is what the food cost per meal.”

Likewise, the company replaced more than 20 position types in the dining department’s labor budget with just four categories: a low-paid and high-paid category for both hourly and salaried workers. Instead of looking at 20 specific positions, says Erickson, the company now measures the number of full-time employees (FTEs) needed to support 100 residents. “A metrics focus is now driving the budgets: when you have 900 residents, you should have X number of FTEs,” he says.

In both cases, the result was less work and better metrics for comparing communities. (It takes an average of seven years for each retirement community to reach a mature level of 2,500 residents.) Once the new system was in place, says Erickson, it quickly became apparent that one campus with 900 residents was paying 25 percent more per meal than another of the same size. “Our use of metrics allowed us to see that this was entirely due to staffing ratios. The way we were budgeting before, we couldn’t see that, because everyone’s head was in the details,” he says. “Our budgets were very precise. But that didn’t mean they were accurate.”

Making Managers Accountable

“Simplification also leads to greater accountability,” observes Serven, adding that “there are fewer places to hide.” Indeed, performance reviews at Erickson Retirement Communities rely heavily on whether managers exceeded the average performance metrics for their size facility, though equal weight is also given to resident- and employee-satisfaction surveys. “In the past, managers had a tendency to pad their budgets a bit so they would be likely to come in under budget,” says Erickson. “With a metrics-based comparative approach, someone who tries to pad their budget is essentially saying, ‘I cannot perform at the same average level as my peers.'”

Consultants have been suggesting for years that greater accountability can improve the effectiveness of the B&P process. In 1998, only one-third of respondents told CFO that senior and mid-level managers were held visibly accountable for achieving the plan. Today, 60 percent say that is the case.

“The immediate availability of current data drives greater accountability throughout the organization,” observes Greg Bozigian, director of financial planning for Carnival Corp.’s Princess Cruises and Cunard brands, referring to the company’s Web-based Cognos planning tool. “All senior executives have access to their managers’ data and can view their subordinates’ latest forecasts and submissions at the touch of a button.”

During review meetings, says Bozigian, when executives and managers gather together, plans can be projected onto a screen, providing far more than just visibility. “If an operator’s [forecast] numbers are not in line with actual trends, or the operator cannot provide adequate justification for the current projection,” he says, “senior executives can change the numbers on the spot. On many occasions, we’ve changed budgets and forecasts in review meetings.”

Accountability can also be tailored to reflect corporate priorities. Two years ago, Hudson Advisors, a Dallas-based commercial mortgage servicer and real-estate asset-management firm, decided that IT expenses were so significant that each department’s IT budget and expenditures would be tracked by a special sub-budget in the firm’s Hyperion Planning system. While financial results are reforecast quarterly, IT spending is tracked, reforecast, and reported monthly by department, says chief information officer Janis O’Bryan. “Now everyone individually feels empowered by their forecast,” she says.

Software Helps

As the experiences of these companies suggest, new software systems can support an improved budgeting process, particularly by sharing consistent information. For example, enterprisewide software helps ensure that every division’s budget is based on the same assumptions. Princess Cruises uses its software to roll out standardized assumptions for interest rates, foreign exchange, fuel costs, and so on.

But the greatest contribution of software packages is their automation capabilities — the ability to free up more time for financial analysis by speeding data-collection efforts, and moving the management of that data out of loosely controlled spreadsheet environments (though many still strive to look like spreadsheets). According to an APQC benchmarking survey, companies that rely heavily on spreadsheets typically take 30 days longer to complete their budgets than those that don’t.

Nonetheless, spreadsheet use remains widespread. Some 67 percent of respondents to CFO’s survey say that, apart from spreadsheets, their companies do not use any enterprise or budgeting software. Relying on spreadsheets, however, means that on average, CFOs spend a third of their time inputting, validating, and correcting plan or budget data, while those with enterprise B&P systems spend a quarter of their time on such tasks.

At AAA Life Insurance Co., the percentage was even worse. Says CFO Jay DuBose, “We were spending 80 to 85 percent of our time making sure the spreadsheets were in sync and 15 to 20 percent analyzing the data.” DuBose is set to roll out a new Cognos system next month to fix the problem. And then you have to add in the wasted reconciliation time, says Clint Allen, Princess Cruises’s manager of financial planning. “You’d send your files out, wait to get your data back, and then lose a week or two just to aggregate it in a form that was useful.”

That time is now spent more productively since the company replaced spreadsheets with a new B&P system. Says Bozigian, “What has changed is the time we can spend on analysis. Qualitative analysis has definitely increased.”

The Tie that Binds

The next goal: to increase companies’ comfort with their B&P improvements, says Serven. Only then will they be able to tie compensation to the process, the ultimate test of accountability. “That was the final mile seven years ago, and it still is,” he says. Companies want assurance that they have identified the right drivers, the targets they have set are attainable, and the projects they have developed to hit those targets will do so. Little wonder, he says, that tying B&P to compensation will take “a couple more years.”

That’s not to say no one has attempted it. John McMahan, who leads The Hackett Group’s Finance Executive Advisory Program, points out that some 13 percent of companies have tied budgeting accuracy to compensation, and another 25 percent are either in the process of doing so or are planning to do so. This huge increase from years past doesn’t surprise him. “Everyone is trying to integrate and align their goals,” he says. “Tying B&P to compensation is just the next logical step in the process.”

Still, making that link to pay or instituting any other process improvement requires firms to remain flexible. “Budgeting and planning can never be stagnant,” says McMahan. “Because of the rate of competitive and global change, the process can no longer be tied to the calendar. It has to be continuous, iterative, and externally focused.”

After all, he says, budgeting and planning “by definition is inaccurate.”

Tim Reason is a senior writer at CFO. Research was provided by CFO research editor Don Durfee.

The Final FrontierCoroporate performance management appears to be moving from buzzword to action item. Four out of five companies have identified nonfinancial measures that drive success, but fewer establish targets or regularly report on them. The acid test of basic CPM, says The Buttonwood Group’s Lawrence Serven, is to accomplish all of those things.

Have identified nonfinancial measures that drive company’s success

81%

Have established short-term targets for those measures

67%

Have established long-term targets for those measures

42%

Have identified specific projects to achieve those targets

62%

Report on the progress of those projects at least as frequently as financial results

51%

Percent of companies that say they do all of the above

17%

Source: CFO survey

Spreadsheet Nation

Love ‘em, hate ‘em, spreadsheets will never go away. Some 67 percent of those surveyed by CFO magazine, representing companies of all sizes, use only spreadsheets for budgeting and planning (B&P). But in this post-Sarbanes-Oxley era, that could be considered risky behavior.

“The built-in flexibility that has made Excel a wonderful financial tool is completely at odds with the Sarbanes-Oxley ‘command-and-control’ requirements,” says Jim Winett, managing director of IC Consulting Services LLC. “Change in controls causes the most havoc,” he says, noting that in theory any change in formula or even number of rows ought to be documented. So despite their affinity for them, one-third of CFO’s survey respondents say Sarbanes-Oxley has made it harder to rely on spreadsheets as part of the business planning process.

Marc Chardon, CFO of Microsoft’s Information Worker division (which is responsible for Microsoft Office and, therefore, for the Excel spreadsheet application), candidly admits that business users struggle with consolidation and access control in Excel. He attributes their difficulty to the application’s evolution from a tool for individuals to a tool that is increasingly used collaboratively on top of business applications ranging from ERP systems to general ledgers to revenue-planning tools.

“There’s an inherent tension between the ‘power-to-the-people’ origins of Excel and the role it is increasingly called on to play,” he says. “We’re clearly aware of that.” Microsoft, says Chardon, is working to make Excel “a better citizen in the front-end process and a better tool for collaborative work.”

Not surprisingly, Microsoft itself uses Excel and SQL Server for B&P, despite the fact that as many as 3,000 people are involved in the corporate budgeting process. At the Information Worker business group, says Chardon, “we have the advantage of having the most up-to-date version and finance people who were involved in the design of the product. That’s why I’m maybe more serene with Excel than other people are.” Indeed, the Information Worker business group is now pre-beta testing the next version of the Office suite, which he hints will contain improvements to Excel’s collaborative and control capabilities.

In the meantime, auditors have identified spreadsheet controls to mitigate financial-reporting risk, including password protection, hosting on protected servers, and locking cells within spreadsheets. — T.R.

The Spreadsheet SpreadCompanies of all sizes say they rely solely on spreadsheets for budgeting and planning, although this is more common among smaller companies (as measured by annual revenues).